In January 2021, the FCA banned discretionary commission arrangements (DCAs), removing the incentive for brokers to charge customers a higher interest rate for their motor finance. A continued rise in the number of complaints from customers about DCAs in place prior to the ban and the recent decisions by the Financial Ombudsman Service (FOS) which found in favour of complainants has highlighted concerns for the sector.

Anticipating a significant increase in complaints to firms and the FOS, the FCA intervened in January 2024, appointing a skilled person to review historical sales of motor finance agreements across several firms involving DCAs. The FCA aims to communicate a decision on next steps by the end of September 2024, and whilst the review remains ongoing, it is likely firms will continue to receive an increased level of complaints.

Similarly, the high-cost short-term credit sector (HCSTC) experienced challenges associated with a rise in complaints relating to historical unaffordable lending practices which led to several firms exiting the market or undertaking a formal restructuring procedure to deal with redress liabilities.

Whilst firms contemplate what, if any, impact the review and increased complaints will have on their business, there are several useful takeaways from the HCSTC sector which highlight matters firms should be considering.

FINANCIAL AND OPERATIONAL RESILIENCE

Financial and operational resilience is key. Firms should be conducting detailed scenario analysis, with cash flow and liquidity modelling, in a range of severe but plausible scenarios enabling management to understand what the business can withstand, both financially and operationally.

This will provide greater visibility of areas of potential stress or vulnerability within the business and clarity on triggers that may lead to underperformance, such as a sudden increase in compensation levels or operational costs related to assessing complaints.

WIND-DOWN PLAN

Firms should ensure they have a well-documented wind-down plan which considers the extent to which the firm may be affected by historical DCAs, including how a remediation exercise and associated liabilities may impact the operational and financial performance of the business.

A robust and deliverable wind-down plan can act as a tool to build stakeholder confidence at a time of uncertainty. It can also assist management and advisers in developing contingency plans in a more efficient and cost-effective manner.

REMEDIATION EXERCISE

Should a firm need to undertake a remediation exercise, consideration will need to be given to these key elements. Whilst not an exhaustive list, it gives some indication as to how complex and expansive a remediation exercise can be:

• Governance framework
  This is vital to aid decision making and co-ordinate a successful remediation exercise. What will the MI reporting suite look like and how timely will it be? How will appropriate oversight be given to any outsourced processes?
• Population identification
  What steps have been taken to identify the population impacted and its various cohorts? Are there any gaps in data or dependency on legacy systems? Have historical debt sales included impacted consumers? Are there contractual claw-back provisions that need to be considered?
• Review methodology
  Does the review methodology cover all scenarios and relevant products? How will appeals, contentious cases or anomalies be dealt with?
• Quality assurance
  What QA will be performed to verify steps taken to identify the population, assess a complaint and calculate redress to ensure customers are receiving the right outcome? Will there be a pilot phase? What metrics will be used to measure success?
• Funding, resourcing, and training
  Has analysis been performed to forecast the financial impact, including operational costs, redress compensation and loan adjustments? How will the remediation exercise be funded? What are the resourcing requirements across functions and what training will be provided?
• Communication and complaints handling
  Has a customer communication plan been developed, including frequently asked questions and redress assessment letters?

Considering support required throughout a remediation exercise can help minimise disruption across the business and deliver a successful, cost-effective campaign.

RESTRUCTURING PROCEDURES TO ADDRESS FINANCIAL DIFFICULTIES

A number of firms in the consumer credit sector have used formal restructuring procedures, such as a scheme of arrangement, to deal with financial difficulties driven by an increase in redress liabilities.

These court-sanctioned restructuring tools can allow a firm to crystallise historical redress liabilities and reach a compromise or arrangement with their creditors which may provide a better outcome than any likely alternative.

Considering support required throughout a remediation exercise can help minimise disruption across the business and deliver a successful, cost-effective campaign.

A scheme of arrangement or restructuring plan can provide finality for firms in respect of their historical redress liabilities and allow a firm to continue to trade which can, compared to an insolvency, improve consumer outcomes. Once there is certainty around dealing with such liabilities, future debt or equity raises become much more attractive to existing and potential investors.

Ultimately, if a business is unable to raise sufficient funds or reach a compromise to deal with any historical redress liabilities, contingency planning should be undertaken to consider other options. This is something that should be considered early to ensure the best possible outcome for all stakeholders, including customers.